Don’t Try To “Go Up Against” The IRS

dttgaFEW THINGS WILL RUIN YOUR DAY MORE THAN receiving an unexpected envelope with Internal Revenue Service marked on the return address. In spite of your best efforts to comply with the law, sometimes things go awry. If you understand the way the agency works, you can settle most disputes relatively quickly. But even when you begin to feel like you’re living inside a Kafka novel, there are a few steps you can take without incurring the cost of a lawsuit.

In two-thirds of small-business-owner clashes with the IRS, simply laying out the facts and answering any of the tax collector’s questions clears up the problem. Most of the rest can be settled within the agency’s own appeals mechanisms. There are two basic problems you’re likely to run into with the IRS: The agency made a mistake in its procedure or you disagree over the total tax due. If your initial responses to IRS queries don’t settle the issue, you will only deal with the agency effectively when you pick the right method for each problem.

With procedural cases–say, you have a canceled check for a tax payment that the IRS says you did not make, or the agency erroneously credited a payment to your personal account rather than your business account–entrepreneurs should “go to the problem resolution officer in their district,” advises David Keating, executive vice president of the National Taxpayers Union. “That should be the first step when they’ve reached the end of their ropes.”

But if the problem is about the amount of the tax–if the IRS decides to audit you and disputes an expense’s deductibility, the reasonableness of compensation, or the method of valuing inventory–ask the agency to refer the matter to an appeals officer. “The appeals officers are sometimes more reasonable than the front line,” Keating notes.

Remember, however, it will be up to you to prove your case in every instance. The IRS doesn’t have the obligation to prove that it’s right, unless you resort to the expensive alternative of taking the government to court. “You’re guilty until you’re proven innocent,” says Craig Willett, who owns a Provo, Utah, accounting firm that specializes in small-business tax problems. “It’s the only system in the United States that’s stacked that way.”

Taxation With Representation

There are times when you have to call in the big guns. Smart business owners know when it’s time to leapfrog the IRS’s chain of command and seek help from someone with real political clout.

“If you’ve been involved with an IRS issue that just isn’t getting resolved, try writing to your Congressperson,” says CPA Martin Kaplan in his book What the IRS Doesn’t Want You to Know (Villard Books). “Typically, someone in the Congressperson’s office calls, followed by someone in the IRS, and in a matter of weeks the issue gets resolved.”

Congressional intervention works best when you simply need someone to listen to reason–that you are not responsible for the tax bill of a company in another state with the same name as your firm, or that the agency should waive a penalty because the reason you were late in filing is that a fire destroyed all your business records and put you in the hospital. Sometimes the IRS employee you’ve been dealing with is simply wrong on the law but needs pressure from a higher-up before he or she will back off.

If you’ve moved through the dispute settlement process and the IRS continues to insist that its position correctly reflects the law, your next move is to see if your Representative can change the law. This happens more often than you might think. Hundreds of technical changes in the tax code are made every year to settle small-business people’s problems.

Rep. Barney Frank (D-Mass.), for instance, originally sought to work out a compromise settlement between the IRS and shipping-boat owners based in New Bedford, Massachusetts. Fisherfolk who crew the boats consider themselves self-employed, because their compensation depends entirely on the size of the catch they make. But–following an old New England tradition–a boat’s mate, engineer, and cook get an extra $25 from the crew’s portion of each week-long trip’s earnings. The IRS feels this turns the crew into employees.

Although the $25 “pers” were dropped in 1988, the family of Boat Niagara Falls president Kathy Downey is facing a past-due bill of some $35,000, with interest. The IRS claims that Social Security taxes are owed for the crew of her husband’s boat. The bill for the entire 110 boats in the New Bedford fleet might top $20 million.

Because his initial efforts were rebuffed, Rep. Frank is now leading an effort to change the underlying law. “The entire Massachusetts delegation has been supportive and they’ve worked hard” says Downey.

Mercy, Me

If you decide to contact your Representative or Senator, get any necessary help from your tax adviser in drafting the letter. If you are arguing for compassion, however, send the letter yourself. Congressional offices also react best when you are in the right and can show that the IRS’s standard dispute-settlement process just isn’t working.

Help from your Representatives in Washington, however, isn’t foolproof. A strong letter from then Rep. Bob Carr (D-Mich.) didn’t help Sharon Herald in her dispute with the IRS over the status of workers at her pet grooming business in Milford, Michigan. “The IRS wrote a separate letter to the Congressman: ‘Thank you for your concern, but it’s no concern of yours,'” she explains. Herald ended up paying the amount taxed plus $2,000 in penalties.

Of course, the best way to handle a sticky problem is not to have it develop at all. Make sure IRS agents see you as a diligent taxpayer willing to pay everything you rightfully owe when you first contact them.

“The more promptly you reply, the easier the IRS is to work with,” Willett says. Writing a rude reply to an IRS communication or ignoring it completely is likely to make a bureaucrat assume that you have something to hide. It might even kick off an intrusive full-scale audit that delves into your family finances when a simple explanation could have settled the matter. And how many of you have the time to spare answering unnecessary questions when you could be landing new business?


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